Why China may finally become an exporter of inflation
- A deflationary force to its trading partners for a long time, China has kept inflation in check largely because of its pool of cheap labour
- But urbanisation is slowing, population growth is collapsing and addressing rampant inequalities is on the government’s agenda
Over the past few decades, China has been a deflationary force to its export destinations through its seemingly unlimited cheap labour and subsidised credit. But that role may be reversing.
China has a long history of high inflation and the past two decades of low inflation is really an aberration. As soon as China started its economic reforms in 1978, its citizens began to struggle with rapid price increases that lasted two decades.
In some years, the official figures for consumer price inflation reached double digits, topping out at 19 per cent in 1988-1989, and 24 per cent in 1994, for example. All the while, the government had to resort to data manipulation and draconian controls to hide the true extent of these price increases.
Right after 1949, China practised three decades of rigid price controls under the Communist government. That led to an ideological delusion that China would somehow never have inflation. University students and academics in the late 1970s and early 1980s (yours truly included) wrote numerous theses to support and justify this delusion.
But rampant inflation raged through China in the 1980s, despite official denials, forcing the establishment to admit a decade later that inflation was possible in China “under certain circumstances”.
China’s governance regime is inherently inflationary. If Beijing wants to engage in expansionary fiscal or monetary policy, or inflate away its debt burden, there are no institutional checks and balances. Unlike many other countries, China does not even pretend to have an independent central bank.
Moreover, local governments are mere support functions of the central government and do not have their independent finance. This regime encourages profligate spending, and free rides on the renminbi.
Unlike elsewhere, the central bank, the People’s Bank of China, has twin objectives: stimulate economic growth and fight inflation. Obviously, the first objective is far more important than the second.
That’s why China’s money supply can only grow fast and very fast. Despite having a much smaller economy than the US, China has a money supply as big as the US and European Union combined. So, it is truly remarkable that China has brought inflation under control over the past two decades.
I think urbanisation is the key factor behind all this. In 1980, only 19 per cent of Chinese lived in cities. But today, that figure is 65 per cent. The huge pool of cheap labour has helped offset an enormous amount of inflationary pressure.
Between the 1950s and 1980s, China suffered a severe shortage of everything, and strict rationing was enforced on grain, meats and white goods, as well as industrial materials.
Shortages have had such an impact on China’s collective psyche that boosting industrial production remains the government’s top focus even today, while everything else takes a back seat. The result of this obsession after 44 years is industrial overcapacity, the disappearance of shortages and even a solid export base.
As China continues to industrialise, it is becoming more at the mercy of global waves of soft and hard commodities. And for that reason, and others, China is likely to become an exporter of inflation in the years ahead.
Joe Zhang, a former economist at the People’s Bank of China, is co-chair of SBI China Capital
